Question 331: A and B are in a controlled group. A sponsors a cross-tested profit sharing plan for its employees only. The plan passes coverage, but my concern is nondiscrimination. When performing rate group testing and the average benefit percentage test, does the plan count the employees of B?
Yes. The general test requires that each rate group satisfies the coverage requirements of Code §410(b) as though it were a separate plan. [Treas. Reg. §1.401(a)(4)-2(c)(1).] To show that each rate group passes coverage, the plan takes "into account all nonexcludable employees regardless of whether they benefit under the plan." [Treas. Reg. §1.401(a)(4)-2(c)(3).]
Let's demonstrate this with an example. In the interests of simplicity, Plan A will test based on contributions rather than benefits. For the moment, assume A is not related to any other employer. All A employees participate. The table shows each participant's 2017 allocation.
|Employee ||Comp ||Contrib ||Alloc Rate |
|HCE 1 ||270,000 ||54,000 ||20.00% |
|HCE 2 ||270,000 ||54,000 ||20.00% |
|HCE 3 ||200,000 ||50,000 ||25.00% |
|HCE 4 ||125,000 ||6,250 ||5.00% |
|NHCE 1 ||80,000 ||2,400 ||3.00% |
|NHCE 2 ||64,000 ||1,920 ||3.00% |
|NHCE 3 ||50,000 ||1,500 ||3.00% |
|NHCE 4 ||40,000 ||8,000 ||20.00% |
|NHCE 5 ||36,000 ||7,200 ||20.00% |
|NHCE 6 ||30,000 ||7,500 ||25.00% |
60% of the participants are NHCEs, and so the concentration percentage is 60% and the midpoint percentage for rate group testing is 45%. The 25% and 20% rate groups each have a coverage fraction of 66.67% and the 5% rate group has a coverage fraction of 50%. Overall, the plan satisfies the average benefit percentage test with 70.48%. The plan satisfies both coverage and nondiscrimination.
But, now suppose A is in a controlled group with B, and that B employees do not participate. B has 1 HCE and 4 NHCEs that satisfy the minimum age and service requirements. Counting all employees of A and B, the plan benefits 6/10 NHCEs and 4/5 HCEs. This gives a coverage fraction of 75%. The plan passes the ratio percentage test for coverage on a controlled group basis.
However, the general nondiscrimination test is another matter.Combining A and B, 10/15 of the employees are NHCEs and so the midpoint percentage drops to 40.5%. However, the 5% rate group benefits only 3 out of the 10 NHCEs, while it benefits 4 of the 5 HCEs, for a coverage fraction of 37.5%. That group does not satisfy the nondiscriminatory classification test. Bringing the employees of B into the test, the plan also fails the average benefit percentage test with 52.86%.
This illustrates a crucial point. We often say controlled group status does not pose a problem if the plan passes coverage. But that is only half the story. The plan must pass both coverage and nondiscrimination, and if the plan is relying on the general nondiscrimination test, then it must pass 401(a)(4) on a controlled group basis.